Are cash rich companies your favourites?

Dec 15, 2010

In this issue:
» Plastic notes to counter fake currency
» FII pullback around the corner?
» Petrol prices may put a brake on auto sector's dream run
» Is oil the next gold?
» ...and more!!

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At a time when the most well to do economies globally are reeling under debt, cash is certainly a prized possession. Especially if yours is a company looking to expand operations with minimal leverage. Very few companies globally have such luxury at the moment. But the fact that India Inc. is reasonably well placed in this regard is not news to us. 580 companies compiled by a business daily sported a sterling Rs 1.5 trillion in cash and bank balances at the end of 1HFY11. Such facts may lead investors in India to jump with joy. But before you do so, probably we should highlight some key aspects of the statistics worth keeping in mind.

First and foremost, despite the enormous amount of cash the 580 companies are armed with; it is barely a third of their total debt. Thus just noticing the cash will be like looking at one side of the coin. Secondly, the distribution of cash and debt is not even. Players in IT, oil refining, commodities seem to be sitting on piles of cash. At the same time sectors like real estate, aviation, retailing and textile contribute to the maximum proportion of debt.

The reason for the cash accumulation is also varied. Some companies have painstakingly accumulated the cash from their internal accruals. Others have simply diluted equity to raise the capital. The latter are therefore certainly not equally credible. Most importantly it is the efficient utilization of cash that will determine investor returns. Companies may be sitting on cash piles unable to undertake capex due to under-utilisation of existing capacity. Other may be on the lookout for acquisition for long. In both cases investors have high risk of losing money if the cash is not employed prudently.

Thus cash rich companies are certainly a value investor's delight. But the cash cannot be looked at in isolation. Else investors may end up committing a grave error in stock selection.

 Chart of the day
Investments by foreigners have been cited as the key reason for the premium valuations that emerging market stocks are commanding these days. So much so, that warnings of a steep correction is already doing rounds. But it seems that a strong pullback of FII money may not be around the corner, yet. As today's chart shows, the gross FII inflow into emerging markets in 2010 is at 2.4% of emerging market GDP. This, when compared to the FII inflows over the past two decades, is marginally higher than the average FII inflow to GDP ratio of 2.0%.

Data source: IMF
Emerging market constituent as per IMF

Is the Indian auto story slowly losing its sheen? First, it was the rise in interest rates. Then came the news that the auto component industry may not be able to meet the rising auto demand. And now, it is the rise in petrol prices that the industry players will have to contend with. Petrol prices, as you all know, are set to go up by Rs 3 per litre. This is the fourth increase in six months and obviously, the auto industry may not be happy with such a development. It should be noted that running cost of a vehicle plays an important role in shaping the buyer decision, especially in the case of four wheelers. Thus, it is quite possible that following the petrol price hike, consumers may want to defer their buying decision. What more, with diesel also likely to get costlier, there seems to be no relief in sight for auto manufacturers.

Counterfeiters seem to be trying their hand at solving India's liquidity issues. This is by printing thousands of fake notes! According to latest data from the home ministry, half a million fake notes worth Rs 214 m were seized in India till October 2010. But this number doesn't capture the actual quantum of fake currency circulating in the country.

To counter this illegal activity, the Government is seriously considering the idea of introducing plastic currency notes. This will help keep in check the problem of fake currency notes. It will also help increase their lifespan. However, this idea is not new. It was first hinted at in 2007. Countries like New Zealand and Australia have already tried their hand at it. It remains to be seen if plastic relieves us of fake currency notes.

Indians have been investing abroad with a bang. As per reports, overseas investments by individuals looks set to cross US$ 1 bn in the current financial year. During the first six months of the current financial year, overseas remittance by individuals went up by over 18% to around US$ 565 m. What is driving this trend is the investment in equities and property. Remitting more money as gifts and for maintenance of close relatives are also factors not far behind. Obviously, the global financial crisis dampened sentiments last year. Now with some sort of a revival being witnessed, there has been a surge in the overseas investment activities of Indians. While property purchases are up by 47% YoY, investments in equities are up 44% YoY. What has gone up the most though is the maintenance for close relatives. This has surged 131% YoY.

Is oil the next gold? Looking at the way oil prices are rising, it does seem so. In fact, some like Marc Faber have even gone ahead and predicted that oil prices will continue to rise in the future. Faber's prediction comes on the back of continuously rising demand from countries like China and India that will keep prices of commodities like oil higher in the future.

Faber also believes that if the world slips into another recession, geo-political tensions would arise resulting in oil-supply cuts. So either way, oil prices will rise! Oil prices recently hit the US$ 90 a barrel mark, their highest levels in two years.

Some positive signs from a recent World Bank report. A recovery is expected in FDI inflows to developing countries. Inflows to these economies are projected to increase by 17% in 2010. The inflow had dropped by 40% in 2009 to $354 bn. The same is expected to touch US$ 416 bn this year. FDI prospects for developing economies seem positive even beyond 2010. This is mainly because their economic growth is likely to outperform that of developed economies. There is something worth noting here. About half of the FDI inflows to developing economies are concentrated in the BRIC countries.

But how much of it is pouring into India? Sadly, FDIs into India have not picked up yet. The inflows for the first half of FY2011 are enough evidence. The amount was $11 bn during April-Sept 2010. It had been US$ 15.3 bn during the same period last year. This amount is almost lower by 30%. Not a very promising sign. On the other hand, heavy FII inflows remain a concern.

Led by weakness in auto, banking and consumer durable stocks, the Indian indices failed to make inroads into the positive territory since the start of the session today. The BSE-Sensex was trading 110 points lower at the time of writing this. The mid and small cap indices were down 1.0% and 0.9% respectively. Other Asian markets closed a mixed bag with the Indonesian and Hong Kong markets leading the pack of losers. The European markets have also opened lower.

 Today's investing mantra
"Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid." - Warren Buffett

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1 Responses to "Are cash rich companies your favourites?"

Praveen Bhargava

Dec 15, 2010

Cash rich companies attract all the favour from all around.The debt-free company is the ideal situation and every company want to become cash rich and debt- free as soon as possible.It makes a company to stand oh its own footing and without any financial help from outside.
It actually help a company to earn more and go for further expansion in its own product as well as other line of activity.It also induce the cash rich company to go for consolidating its position by merger and acquisition around the world.
The cash rich company is also very much favoured by banks for any type of loan if required if the situation so demand in times to come.
I always prefer to have shares in my kitty of cash-rich companies.

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